How to Start a Nonprofit Organization (Step-by-Step)
While nonprofit organizations are not the same as a business, there are similarities in the startup process. It is important for anyone looking to start a nonprofit to ensure that they meet all requirements, maintain the correct tax status, and operate effectively.
Read on to learn about why you may choose a nonprofit and if it’s right for you.
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What is a nonprofit?
A nonprofit is a type of business organization that operates and provides services without the primary goal of making money. Existing organizations serve the public interest and, in return, are usually granted a tax-exempt status through the Internal Revenue Service (IRS).
Nonprofits can be formed in a variety of ways, but they are often a form of corporation formed under state law, which means they may need to follow regulations like annual reports that other corporations must follow.
Nonprofits can also qualify under the 501(c) federal corporate tax exemption, which exempts them from federal corporate taxation.
The different types of nonprofits
A nonprofit organization can organize in three ways when it comes to the structure of the business. There are also additional classifications that can be used for tax status through the IRS. If you need help selecting a type, it’s best to seek legal advice.
Association
An informal group of people who come together for a common purpose can be considered an unincorporated association. This may be a bridge club, a neighborhood watch association, or any other hobby group. These associations have some legal rights, like opening a bank account, but they also have liabilities. For example, if the members of a club are in a car together and get into an accident that one member caused, all members could be held liable for damages.
Groups become associations when they begin generating income, applying for grants or deductible donations, or otherwise conduct business outside of the group.
Trust
Certain nonprofits are formed as trusts, such as charitable gifts made in wills. This is typically not the best format as trustees are not protected against liabilities. Trustees are held to a high fiduciary standard, which means they must be very careful, and this is usually not the chosen structure unless it is mandated.
Corporation
The most common, and usually best, form for a nonprofit to take is a nonprofit corporation. The nonprofit needs to file for incorporation and maintain periodic filings and disclosures like any corporation would, but they also receive a number of benefits.
Corporations offer the most protection from liability, which is important for any business, especially those that are not generating profit.
Many grants and funds that nonprofits can receive are available only to incorporated organizations, as they are considered the safest and most legitimate. Because there is no profit, there isn’t the same tax burden as other corporations may face.
Tax statuses
You may have heard nonprofits referred to as 501(c)(3), as this is the most common designation under IRS law. However, there are actually 29 kinds of 501(c) organizations that each have different rules surrounding taxation. 501(c)(3) refers to religious, educational, charitable, scientific, and literary, testing for public safety, fostering national or international amateur sports competition or prevention of cruelty to children or animals.
One of the main distinctions between these forms of nonprofits is whether contributions are deductible for the donor. They are in 501(c)(3)s, but many others do not allow this.
Who should form a nonprofit?
Nonprofits are not an alternative for profit businesses. If you are planning to start a business for the purpose of making money, then a nonprofit is not a good choice.
However, if you would like to form an organization around a charitable cause, a nonprofit is your best choice. Anyone looking to do so, whether as their job or as a side venture, can do so through a nonprofit. Doing so can add liability protections and formality to your cause and allow you more freedom to do more service.
Advantages of starting a nonprofit
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Social good
A nonprofit is by definition an organization that performs well for society. Nonprofits generally exist to make a mark on the world.
If you have employees, they often are committed to your cause and will often help with everything from fundraising to meeting nonprofit compliance codes.
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Tax-exempt status
When the IRS recognizes your organization as a nonprofit, it can have both tax and financial benefits. You may be given good terms and discounts due to this status and will not owe taxes on money coming in through donations. There is no corporate income tax imposed on nonprofits, even when there is a small profit margin coming in. Donations are also tax-deductible for donors, which makes you more likely to receive funds.
Nonprofits can usually file for state tax exemption as well, although the rules vary from state to state.
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Personal liability protection
Because a nonprofit can be formed as a corporation, it has the highest possible level of asset protection. Founders, officers, and employers are not held accountable for debts, obligations, and lawsuits related to the organization. Since many charitable organizations work directly with the public, this can be even more important than in other businesses.
Disadvantages of starting a nonprofit
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Funding sources
As an organization not bringing in profit, nonprofits need to maintain a cash flow in some manner. They may rely on individual donations, which can be unpredictable and hard to incentivize. Grants and funding are available, but they are also very competitive and can take a lot of skill to properly obtain. Even without a profit margin, these organizations can struggle to bring in enough to continue their work.
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Heavy scrutiny
Nonprofit organizations must share their financial statements with the general public in order to provide accountability. However, it can also garner a lot of press coverage and negative opinions, especially during hard times. Social pressure from the public can make nonprofit work even more difficult. This is all in addition to the higher level of scrutiny from the IRS, which will work to ensure all qualifications are met.
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Corporation regulations
Outside of taxes, a nonprofit will be treated as a corporation in its home state. This means keeping up with annual reports and filing fees, formal articles of incorporation, and board meetings that must be tracked meticulously.
Steps to set up a nonprofit
1
Name your nonprofit
Like a business, you will need to choose a name for your nonprofit that meets state requirements, including being a unique name within your state. Some states will require the nonprofit to have a corporate designator like Company or Limited at the end of the name.
Once you have a name chosen, you file registration forms with the state.
If you want to operate the nonprofit under a different name than you will list on the articles of incorporation, you need to file for a fictitious name or doing business as.
2
Form a board
You may need to list your board members in your official filing to incorporate in some states, but even if you do not, this is a good step to take early. Board members can help with the process of establishing your business and share the burden with you when it comes to paperwork. You may appoint yourself a member of the board and then choose if you’d like others to join as well.
3
Write bylaws
Bylaws lay a foundation of operating rules and procedures for your new nonprofit. These will provide a framework for your management procedures and foster accountability within the organization. These are not always a requirement for incorporating, but will be in some states, and are generally a good idea.
Bylaws for public charities should include general information, a determination letter, mission statement, leadership, voting process, rules, and a dissolution process.
4
File Articles of Incorporation
Each state will offer formal articles of incorporation for you to complete and file. Within these documents, you will declare your nonprofit’s name, location, purpose, Board of Directors, and the name of your registered agent. This filing will apply to your state, not the federal level, but you should specify if you intend to file for federal tax-exempt status. Remember there may be a filing fee associated with this step.
5
Obtain an EIN
The IRS uses EINs, or Employer Identification Numbers, to represent each business to the federal government. Even if you do not have any employees, you can file for an EIN easily online. This will help the IRS track your activity and allow you to do things like open a bank account for your nonprofit. You must obtain an EIN before you can be eligible for tax-exempt status.
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Apply for 501(c)(3) tax-exempt status
To apply for exemption with the federal government, you will need to file IRS Form 1023-ez, preferably within 27 months of the date you file your articles of incorporation. Depending on your application method, there will be a fee of $275 or $600 and the IRS can take 3 to 12 months to return a decision. They may also reach out with questions during this process.
Officials want to see l that the organization is created and designed only to fulfill 501(c)(3) purposes, has no conflicts of interest, and will not benefit anyone in the form of profits.
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Maintain requirements
A 501(c)(3) designation does not require renewal, but there are annual reporting requirements from the federal government. Depending on the form of financial activity, you will need to file some version of Form 990, which shows finances, activities, governance processes, executive directors, and key staff. These reports will be published for the general public inspection. It is important to keep accurate and detailed reporting.
The state will also have similar requirements surrounding reporting and requirements.
Resources
- The IRS provides information on how to form a nonprofit and internal revenue code you should follow to file income taxes.
- The IRS guide to applying for a 501(c)(3) tax-exempt status.
- Tax basics for maintaining exempt status.
- The U.S. Small Business Association has information on how to register with federal and state entities.
- Use these templates to create a nonprofit business plan.
- The nonprofit compliance guide is helpful.
- This website has a directory of all Secretary of State offices and websites for easy access.
- FAQ on Form 1023 from the IRS. The IRS also offers webinars and tips on social media for nonprofits too.
FAQS
Can nonprofit owners make a salary?
Yes, nonprofits are allowed to pay their employees and owners a salary. These organizations can have money come in through grants, funds, and even sales, as long as they are not making a profit. Financial statements are shared publicly so there is usually some pressure for salaries to be reasonable and not excessive.
Does it cost money to start a nonprofit?
Outside of normal nonprofit startup costs, there are some expected administrative costs when starting a nonprofit. Filing fees may be associated with registering a name, filing articles of incorporation, obtaining local licenses and zoning clearance, and filing for federal tax exemption. Some of these may also happen on a recurring basis.
While it is not required, many organizations will also choose to use a lawyer when drafting bylaws and other documentation.
Do you pay taxes in the nonprofit sector?
A nonprofit is exempt from corporate taxation at the state and federal levels. They will also be exempt from paying sales and property taxes. However, they will still need to pay any taxes associated with employment, like Social Security and Medicare.
Do nonprofits have to be incorporated?
Nonprofits can be formed as associations or trusts rather than corporations. This will not offer the same protections as incorporating a business but can be less expensive and simpler. Associations and Trusts aren’t tax-exempt organizations.
Can an LLC be a nonprofit?
Some smaller nonprofits do operate as LLCs, and some states have hybrid business structures. For example, the low-profit LLC is structured as an LLC but must have a socially beneficial purpose. This can be a very complex option and is not as common.
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